ITG is urging Asian fund managers to improve their comprehension of e-trading costs to save money and thereby increase returns, arguing that many overpay relative to execution performance.
The agency research brokerage studied over $1.3 trillion of Asia-Pacific buy-side trading activity from January 2009 to end-June 2010 to determine the relationship between trading performance and commissions paid.
It found that buy-side firms often pay more not only on the higher visible cost of commission, but also on the hidden performance cost of paying more to get a trade done.
This was particularly the case for small orders (see image, left), where paying a higher commission rate generally resulted in poorer execution performance and created far higher total cost. For orders of less than 1% of average daily volume (ADV), the average cost was more than twice as expensive overall.
For a firm paying $1 billion, this equates to paying $4.6 million more in costs when selecting a high-touch (via sales trading desks), high-commission strategy.
Buy-side traders can also choose to use a low-touch (electronic algorithm/DMA) trading strategy, which usually comes with lower commission rates from brokers. ITG encourages buy-side traders to use low-touch, low-commission strategies for small orders (less than 15% ADV).
Asked why the difference in cost was more pronounced at the lower ADV end, Ofir Gefen, ITG’s head of research, suggests: “At this point we don’t know the real reason, but I believe that when a buy-side trader trades their own orders through a DMA or an algo channel they may well pay better attention than when they give these small orders to a cash desk.
“But the fact that you pay more commission and that you are not getting better execution performance, and overall costs are higher, that is something that people should look at.”
Gefen notes that education levels around e-trading transaction costs are generally better in the US and Europe amid more rigid regulation.
“In Asia, because there is no unbundling, because there is no regulation around paying for research, what happens is there is not much understanding of transaction costs probably at higher levels of organisations.
“Understanding how much you are paying for trading and where those payments go is a key aspect. The research showed us you can actually save money for the fund and as a result improve returns because a lot of execution costs come out of the bottom-line performance of the funds. So you can reduce those costs, and as a result retain more of your alpha as a fund manager.”
He suggests an unbundling of services and the use of Commission Sharing Agreements to identify the value of research would enable the cost of getting a trade done to be measured separately, increasing transparency.
In terms of implementation costs, Gefen estimates it is still 25% more expensive to execute trades in developed Asia (ex-Japan) compared with the US and UK, although he says the gap is narrowing.
“There are levels of complexity in Asia that don’t exist in other markets, and the liquidity in Asia is still not what it is in the US or European markets,” he reasons.
“But I think a part of it is the regulation around best execution. And the development of competition for execution venues, [is another] reason why transaction costs in general in markets like the US and Europe have gone down.”